In his book titled What It Takes: Lessons in the Pursuit of Excellence, Stephen Schwarzman, the co-founder and CEO of The Blackstone Group mentions an interesting auction scheme that he came up with when doing mergers and acquisitions. He calls it two-round sealed bid auction. I am not aware how common it is, but I found it interesting enough to write about it and add it to my writing collection.
Auctions are like little games with very interesting and spontaneous properties, and analyzing them in detail could lead to a sort of enlightenment. For this post, a brief summary is the only goal.
English Auctions
English auction is the auction we are all familiar with. The auctioneer describes the item for sale, sets a base price, and then the participants i.e. the buyers would compete with each other. The bidder with the highest bids wins, and finalizes the sale. Bidders and price drive an English auction.
Dutch Auction
Dutch auctions are partially driven by time, and can be used when the object has to be sold fast. As a matter of fact, eBay used to use a variant of dutch auctions, and IPOs in financial markets use them too- claiming that it is more efficient. Here, the auctioneer sets the base price and keeps lowering the pricing until there is a bidder. Upon finding the first bidder, the auction is over.
Sealed-Bid Second-Price Auction (Vickrey Auction)
This is a single-shot auction. All the bidders seal and submit their bids, and the winner is the one with highest bid. However, the winner pays the price of the second highest bid. Vickrey auctions have their own benefit in that everyone is trying to the real value of item being auctioned, and is not trying to compete with other bidders- auctions for online advertisements, wireless network spectrum, etc. are settled in this way. If you haven’t noticed yet, in such auctions, you get to bid only once throughout the auction!
Single shot auctions minimize bidders competing with each other. Bidders rather focus on the value of the object being auctioned.
Two-Round Sealed-Bid Auction
I am going to call it Schwarzman Auction, as according to him it was largely unknown in the private equity work until Blackstone Group started using it (circa early 1980s). In this auction, the bidders first submit their initial bidding. The auctioneer then drops those “just fishing” with their low bids. For round two, the bidders would be given more details about the product. In Schwarzman’s case case, bidders were given ‘insider look’ into the management, etc. and invited for a second round. The highest bidder in round two wins the auction.
The goal with such an auction, as much as I can figure out, is that the bidders don’t try to asses each other and bid against themselves. They rather realize that all those who got invited to second round were worthy bidders and start sensing the competition. Having more information after round one, they try to bid as high as possible to win the bid, and not just a dollar or two to outbid the second highest bidder. The auctioneer gets the highest possible price. The bidder is happy and comfortable too.